Q4 2022 DigitalOcean Holdings Inc Earnings Call
Good morning, My name is Rob and I'll be your conference operator today at this time I'd like to welcome everyone to the digital Ocean fourth quarter 2022 earnings Conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session.
If you would like to ask a question. During this time simply press star followed by the number one on your telephone keypad. If you like to withdraw your question again press. The star one. Thank you Rob Bradley Vice President of Investor Relations you May begin your conference.
Thanks, Rob and thank you and welcome everybody to digital Oceans, Q4, 2022 earnings call.
Joining me today is yancey Spruill, our Chief Executive Officer, <unk>, <unk>, our Chief Financial Officer.
Before we begin I want to cover our safe Harbor statement.
During this conference call, we will be making forward looking statements.
Including our financial outlook for the first quarter and full year as well as statements about our goals business outlook industry trends market opportunities and expectations for future financial performance.
All of these statements are subject to risks uncertainties and assumptions.
You can review more information about these and the risk factors section of our filings with the SEC.
We remind everyone that our actual results may differ and we undertake no obligation to revise or update.
Any forward looking statements.
Finally, we will be discussing our non-GAAP financial measures on our call and reconciliation between our GAAP and non-GAAP financial results can be found in our earnings press release, which was issued earlier this morning and in our Investor presentation, which can be found on our website.
With that let me turn the call over to our CEO Yancey Spruill.
P.
Thanks, Rob Good morning, and thank you for joining us.
I would like to welcome Matt Steinberg, who joined as our CFO in early January .
And is integrating nicely with our team.
And as you'll see shortly he's coming up to speed quickly.
I'd like to start with a recap of 2022 and share our initial thoughts on growth and profitability for 2023.
Including detailing our key initiatives for the year.
And then turn it over to Matt to provide more color on our results and our financial outlook for 2023 and.
And share more about our capital allocation strategy.
Okay.
To say the very least.
2022 was an odd year.
The first quarter was strong by early Q2, we saw an emerging dynamic where both new customer acquisition.
Spansion, our cohort of customers began to slow.
Despite executing initiatives throughout the year to boost growth. We saw continued slower growth in our existing customer cohorts in new customer acquisition.
And that has continued into 2023.
The three key headwinds that drove this slowing growth were first general softness across our existing customers in terms of slower expansion and more volatile new customer additions.
Particularly among smaller customers.
Spansion decelerated to 400 basis points across the year.
<unk> sure.
<unk> largely remained in line with prior periods.
We've consistently heard from our customers through formal surveys that despite their businesses, having slow they continue to see us as a critical part of their business operations and that they arent looking to move from digital Ocean.
Second the collapse of bitcoin devaluation and its impact on our customers and blockchain, which represented 5% of total revenue at the peak in Q2, but declined one 5% as we exited the year and.
Finally, falloff from the warranty Ukraine as customers in Russia, and Ukraine combined represented nearly three 5% of total revenue at the peak in Q1 of last year.
But declined to less than 2% as we exited 2022.
We see the consumption based revenue model is a strength of our business long term, particularly in driving customer loyalty because of the flexibility. It offers them in good times and challenging times like these when their volumes decline.
Having said that.
Our model does enable more volatility with existing and new customers in times of deceleration.
We've experienced beginning in 2022.
Yet despite these headwinds we delivered strong revenue growth with significant increases in operating and free cash flow margins.
These improvements were the result of our pulling multiple levers, including introducing new product capabilities raising prices for the first time in our history prioritizing investments and expanding our product set with a highly strategic acquisition of cloud with for.
For the year, we delivered $576 million in revenue, which represented 34% year over year growth.
We were also able to make meaningful progress on our profitability and cash flow profile during the year to get ahead of the softening macro environment. In Q2, 2022, we began to rein in spending by narrowing our investments to those that we expected would have the largest impact on growth.
Managing the business to higher free cash flow, while weathering the uncertainty.
Those decisions paid off as we both increased improved free cash flow margins throughout the year.
And position ourselves to see the growth from those re prioritized investments in 2023.
We delivered adjusted EBITDA margins of 34, 4%, which were up 200 basis points year over year.
Additionally, non-GAAP operating margins were 18% up 600 basis points year over year.
We also made continued progress managing our capital spending footprint as we delivered capex of 21% of revenue.
400 basis points from 2021, well.
While balancing investments across the shorter and longer term.
An example of longer term capital investments.
The launch of the Sydney datacenter in Q4 of last year.
We are already seeing strong revenue traction in Sydney and that will be a meaningful boost to 2023 growth.
As a result of the strong revenue growth improving margins and leverage on capital free cash flow increased 217% year over year to $78 million or.
We're 13% margins, a 700 basis point improvement from 2021.
And a major step towards our longer term margin target.
With a solid fourth quarter and full year 2022 performance behind us in light of the challenging macro conditions, we are recessed reassessed, our near term revenue growth and margin targets.
Since our 2021, IPO, we share targets of delivering $1 billion in revenue and 20% plus free cash flow margins in 2024.
While growth was 30% or better we were comfortable ramping to a 20% or better free cash flow margin target over a number of years.
Given the lower growth environment, we are accelerating free cash flow margins to our longer term target range. This year.
And at the same time, we are pushing out the $1 billion revenue target by one year to 2025.
In response to the softer growth environment yesterday, we announced the difficult decision.
To reduce our team as part of a broader initiative to rightsize our cost base.
The actions, we have taken better align our cost footprint to the current and expected growth reality.
And will enable us to deliver a compelling balanced growth and profitability profile, regardless of the economic climate as we continued to pursue our goals of scaling this business.
As we contemplated these difficult decisions, we reviewed all aspects of our business with a goal to improve focus efficiency and operating velocity.
From this review the actions we are taking will help us simplify our structure and also we will rebalance our talent to more closely align with our global customer base.
While the overall impact to the broader digital Ocean team a net decrease in our head count of 11% makes the decisions difficult.
They result in a more nimble organization, enabling a much stronger operating profile now.
While also freeing up investment capacity for targeted growth initiatives as we move forward.
As a team we have relied on a return on invested capital framework to determine how we allocate resources.
And that's an important context for why we emphasize our balanced orientation to deliver strong growth with consistently ramping free cash flow.
Our strategy is ultimate goal is to drive compelling returns.
As we believe it's the ultimate Northstar measure of the performance of every business in any sector in any economic environment.
To be crystal clear.
Growth is core to our strategy and we continue to invest to drive rapid and durable top line growth.
What we are clarified today is our approach will be to continuously improve the returns on invested capital in the context of balancing our investments in revenue and free cash flow growth.
Okay.
Now I would like to turn.
Turning our attention to 2023.
We believe we are still in the early innings of realizing digital oceans potential in a large global and highly diversified market, serving small and medium sized businesses.
Creasing Lee, we are focusing more and more effort towards SMB that collectively spend more than $98 billion annually on cloud infrastructure.
Our growth investments this year, our primary focus on three key areas product enhancements sales initiatives and cloud based synergies.
Together these initiatives will expand our wallet share with our customers enhance our go to market motion and build our customer engagement muscle tracking.
<unk> tracked in the REIT SMB customers to our platform and enabling them to purchase more products from us will drive increased consumption and result in higher net dollar retention and average revenue per customer.
In a few minutes, Matt is going to share his fresh perspective in regards to the details of the drivers of our revenue growth.
As we've disclosed previously our revenue is predominantly coming from a small percentage of our total customers those customers typically start very small and after spending some time learning and testing ideas many of them ramp usage on our platform.
Once they launch it application that gains traction they move into a phase where they are building and scaling our business. We used a $50 per month threshold as a marker for when customers transitioned from learning and testing to building that scaling.
In Q4, 86% of our total revenue was derived from customers that are spending more than $50 a month.
Despite those customers, representing just 21% of our total customers importantly.
Importantly revenue from $50 per month customers grew 39% last year.
Despite the overall economic weakness and these trends have much higher customer and revenue growth with better unit economics from our larger customers.
Have been a consistent pattern for a number of years.
When we speak to investments in product development and go to market. Our focus is on attracting retaining and growing these larger customers.
A portion of the targeted incremental growth areas in 2023 will come through the roadmap of enhancements that we will introduce a course of this year.
Today I'll highlight one of our key investments augmenting our storage capabilities.
As outlined last year, we are prioritizing building out our storage capabilities, which is a significant growth opportunity for us.
We generate roughly 10% of our revenue from existing storage products and we are targeting to increase that proportion of total revenue by as much as <unk> with the investments we are making.
This represents a significant <unk> growth opportunity with existing customers as customers, who use our storage. Today, then roughly two five times more than customers who don't.
While we have storage products today. They are mainly focused on serving a narrow set of use cases and the needs of smaller businesses within our customer universe.
The investments we are making are designed to extend our capabilities to serve a larger set of existing smbs that is to say builders and scalar <unk> as well as become more attractive for new customers to migrate their cloud workloads by adding capabilities to our storage broker we will enable an increasing number of use cases as well as larger scale use.
Mrs.
The Snapshooter acquisition announced earlier this year as part of this broader effort to enhance our storage offerings on.
On the sales front, we are investing in a direct sales effort, while we have a low cost and efficient self serve motion, which has been the key to achieving our current $659 million our business direct sales will help unlock the immense potential of our installed base as we continue to scale in the years ahead.
As mentioned earlier, we have more than a 140000 builders and scales that are spending more than $50 per month with us.
Ross last year, we added to our team to engage deeper with our existing cohorts through our inside sales motion and additional focus of our sales efforts is bringing new customers to our platform principally through build out of our partner channel effort partner pod.
There are hundreds of thousands of digital agencies in managed services and hosting providers around the world and delivering a tailored value proposition to them to be an important growth driver as we make it easy for these channel partners to deliver their customers to us.
Finally, we see significant growth potential from our recent cloud ways acquisition.
Cloud ways has outperformed our expectation in the short time since we acquired them despite the weaker macro environment.
The highly strategic acquisition broadened our product suite from the core digital Ocean do it yourself.
Good model to include a managed cloud service experience for the many SMB customers, who want more help initiating an operating their cloud infrastructure.
Cloud ways managed approach gives us a deeper understanding of SMB customers and their usage of cloud infrastructure.
We're taking these learnings and applying them to our broader business, which will enable our combined business to better match customer what's with the capabilities on our platform.
As an example, the early returns on the deal we've been able to accelerate cloud ways, new customer acquisition by more than 15% for $50 and up customers.
This validates one of the core premises of the transaction that many customers who sign up for digital Ocean would benefit from and would be willing to pay for a managed hosting experience we.
We are actively working on evolving the digital ocean customer onboarding process to better optimize the customer starting point.
The goal here is to better identify those customers who are running our intend to run our business in the cloud.
The earlier, we able are able to identify them the better we are able to engage and serve them and there is a significantly higher customer lifetime value when we do and thats going to be the focus for us.
In summary, despite a difficult environment in 2022, we strengthened our business through organic and inorganic initiatives and delivered strong financial results. We continue to be well positioned to capture share the $98 billion market for developers and Smbs cloud infrastructure, we are focused on realized.
And it's exciting long term growth opportunity and through our actions have committed to doing so while also delivering compelling returns on invested capital regardless of the economic climate.
I would now like to turn the call over to Matt who will provide details on our financial results and our outlook for this year welcome aboard Matt. Thanks, Nancy good.
Morning, everyone and thank you for joining us today on our Q4 2022 earnings call I am very excited to be here and to participate on my first earnings call as digital oceans, Chief Financial Officer.
Well I just recently joined the company earlier this year have already witnessed in our fourth quarter and full year results. One of the key reasons why digital Ocean was so appealing to me in the first place.
I consider myself very fortunate to have joined an organization thats delivering very healthy topline growth as a strong capital structure and is generating meaningful and growing free cash flow on both an absolute and per share basis.
Another appeal for me was the Companys strong competitive differentiation and large addressable market with ample room to grow and to improve return on invested capital.
I see a tremendous opportunity ahead for digital ocean as it is positioned both to grow along with the large addressable cloud market and to capture additional market share. We have a great brand and platform that is specifically tailored to the SMB market.
The company's focus on simplicity excellent price to value and strong customer satisfaction has enabled us to carve out a leadership position in this attractive and growing segment of the market outside the focus of the large hyperscale.
Yes.
Third important factor for me joining on top of the strong financials and compelling competitive position was the quality of the management team digital auction.
<unk> had previously worked with the <unk> group, which at the time was a publicly traded multibillion revenue communications infrastructure company, where I was the CFO and he was the lead director and we're together we successfully executed a $14 5 billion take private of the company.
From that experience I have a tremendous amount of respect for yancy and have grown to respect the executive team that he's assembled and I'm very excited to join that team and to work alongside him again.
To give you a little context for the experience base that I bring to digital Ocean I have a diverse background I was the CFO of a large public company that was a co founder and CEO of our software as a service company and I've held a variety of consulting and strategy leadership roles.
I am excited to be here and I'm committed to bringing a full experience to bear to help us achieve our long term revenue profit and cash flow goals.
Before I review the financials I'd like to share an important observation that I hadn't truly appreciated from the outside and I don't believe the market is fully internalized either.
Insight comes from within the incredible customer dynamic did digital ocean enjoys that has helped propel the company's impressive track record of growth to date and it will be the engine that drives us forward as we achieve our long term objectives.
From my early conversations with Yancey I appreciated the efficiency of digital oceans, primarily self serve go to market model.
Was impressed with the company could spend so little on sales and marketing and yet attract so many customers through its self serve pump.
<unk> more than 10 million unique visitors each month and building a vast customer base numbering 6600 77000 at year end was pretty remarkable.
But I hadn't appreciated totally though was the durability of the resulting customer growth model.
Digital Ocean is compelling cloud platform, where developers and small business can come to test and experiment as they work on their ideas and their ambitions.
While the total number of customers at any point is impressive and meaningful focusing on that statistic by itself masks, the elegance and the strength of the digital Ocean model.
Our customers start their lifecycle simply as testers of our platform spinning up a single droplet exploring our platform trying things out for a couple of months.
<unk> of these testers come to our platform each month through our direct marketing and promotional investments and irregular portion of these testers get traction and become true ongoing customers sticking on our platform and continuing business with us for longer than three months.
While not all of our testers go on to become long term customers. The cost of acquisition is so low that is worth the investment to give them exposure to our platform as they may come back to us down the road to test out a new idea for business.
Once a customer has gone beyond the tester phage may become our learners spending less than 50 per month as they continue to work on their ideas. There are hundreds of thousands of these learners on the digital auction platform 468000 as of December 2022.
While these learners have modest spend individually they are relatively stable as a group with 20% year over year revenue growth and with modest churn. The average learner has been on our digital auction platform for 48 months.
And this is where the insight comes in that.
This large group of learners, who are the stated target audience when the company was founded.
As a feeder for but not the driver of the value and growth in digital.
From this large and stable pool of learners, a regular stream of customers each week and each month and each year find success with their ideas and their businesses begin to grow with their growth comes larger demand for cloud infrastructure and more spend with digital auction.
As these customers grow to become builders, who spend between $50 and 500 per month.
And then scalar who spend over 500 per month, they become stickier and stickier with faster revenue growth lower churn and more product attachment as they scale <unk>.
Collectively these builders and scalar represent only 21% of our customer base to drive 86% of our revenue.
And as customer tiers grew revenues, 30% and 45% respectively in 2022.
Importantly, while the rate of growth of the overall number of customers has slowed down over the past several years. The graduation rate of learners to builders and scalar has steadily accelerated on both percentage and absolute terms fueling digital oceans growth.
As a result, there are 321% more builders today generating 320% more revenue and 423% more scalar to date generating 472% more revenue despite our learner pool, having only 140% of the customers and 181% of the revenue it had five years ago.
These larger customers are the primary focus of the growth investments Yancey shared.
Our investments will help maintain our large and healthy pool of learners, while nurturing our existing customers to support them as they grow into the higher spending cohorts.
We will also continue to work to migrate similarly mature and growing SMB customers directly onto digital ocean from other cloud providers.
These investment initiatives, whether enhancing our storage offering or expanding our direct sales efforts are very focused on expanding our ability to serve this growing base of customers as their cloud infrastructure requirements expand with their business.
Given the importance of the customer growth model, we will begin disclosing customer accounts.
<unk> and revenue growth rates at this more granular level and we will no longer be focused so much on total customer count and our regular disclosures.
I'd like to now shift my comments to our financial performance in 2022, after which I will provide more context for our expanded share repurchase program and our 2023 financial outlook.
As <unk> indicated 2022 was a very unique year. The company was able to deliver strong results. Despite a number of macro headwinds.
It delivered 30% plus top line growth with meaningful improvements in both profitability and cash flow, while completing a highly accretive acquisition of one of our largest customers.
Beginning with the top line, we delivered $576 million of revenue in 2022, which was up 34% year over year.
We ended the year with $659 million, an IRR, which was also an increase of 34% year.
Through improved procurement processes and better server utilization GAAP gross margins increased to 63% up 300 basis points from 2021.
Through disciplined operating expense management, we saw a substantial increase in non-GAAP operating income delivering 18% in 2022 up from 12% in the prior year.
Adjusted EBITDA improved to 34% from 32% as we prioritized and focused our growth investments in light of the anticipated ongoing top line pressures.
Capital efficiency also improved with capital expenditures as a percentage of revenue coming down from 36% back in 2020, and 25% in 2021% to 21% in 2022.
This improved capital efficiency has been deliberate and we have confidence that we will continue to drive further efficiency improvements, even as we invest to grow revenue.
As evidence of our continued commitment to growth investments, we expanded our geographic reach into another attractive market by opening a new data center in Sydney and investment that has already begun to contribute to growth in 2023.
As Yancey mentioned free cash flow and free cash flow per share our northstar metrics and this is true now more than ever in this challenging economic environment.
We've made great progress on these critical metrics and as Nancy and the team have often said, we're just getting started.
Free cash flow in 2022 was $78 million, which was 13% of revenue of 217% increase from the prior year.
On the back of the strong performance in 2022, and our announced cost reduction initiatives, we have confidence in our plans to pull forward our longer term free cash flow targets and exit 2023 with free cash flow margins in the high <unk>.
One of the other key priorities in my first months at the company has been to determine the most appropriate capital structure for the company base.
Based on this work I am excited to share more detail around the capital allocation strategy that we announced today.
Given the reality of the near term macroeconomic environment in conjunction with the maturation of our business model. We are conservatively bracing ourselves for the potential that our growth rates will be in the low to mid <unk> in the years ahead.
In light of this growth profile, we're taking immediate actions that will both boost our margins in 2023 and position us to generate annual free cash flow margins of 30% plus in the coming years.
Our continued revenue growth and increasing cash flow margins combined with our sizable cash balance will result in our building significant cash in the coming years.
We will use this cash to both fund ongoing investments in our products and platform and pursue additional accretive M&A.
But even after those investments we are projecting to have material excess cash given our strong cash flow generation.
Our plan is to return a meaningful portion of this excess cash through our regular share repurchase program.
We believe an ongoing buyback program creates a compelling investor thesis for digital function when combined with our focus on driving operational excellence and profitable growth and together will drive total shareholder return.
In support of this capital allocation strategy I'm pleased to share that our board approved an expanded share repurchase program that allows us to repurchase up to $500 million of our stock in 2023.
We are committing to purchasing a minimum of $230 million in 2023, and we are authorized to repurchase up to another $270 million based on market conditions and our relative investment alternatives at the time.
We expect to keep an ongoing repurchase program in place beyond 2023, and anticipate additional repurchases in 2024 of up to 125% of the free cash flow generated today.
We're excited about this capital allocation framework as it will substantially accelerate free cash flow and earnings per share, while both allowing us to invest in our business and enabling us to remain within our long term target leverage range of $2 5 million to three times net leverage to adjusted EBITDA.
To close my commentary I will provide our outlook for the first quarter and the full year 2020, but before I do I'd like to share some context for how we thought about guidance in light of the uncertainty and headwinds facing the software market in March.
Given the various macro uncertainties, our annual guidance range will be a bit wider than we have historically provided which we believe is appropriate in this environment.
The low end of our range represents our current run the business trajectory adjusted downward somewhat to reflect a continued challenge growth.
The high end of the range assumes we see solid incremental traction throughout 2023 from our key growth initiatives that Yancey explained earlier.
I'd also like to highlight that beginning with this earnings call, we will be guiding to and reporting adjusted EBITDA as our core profitability metrics. This will closely align with our our external guidance to one of our key internal metrics as we measure the business internally using this metric and we believe it appropriately demonstrates the performance of the business.
In terms of specific guidance for Q1, 2023, we expect revenue to be in the range of $163 million to $165 million.
For the first quarter, we expect adjusted EBITDA margins to be in the range of 31% to 32% and non-GAAP earnings per share to be 2008 2009.
With the announced cost reduction actions implemented and behind us by the second half of the year, we expect that we will exit the year with adjusted EBITDA margins in the low to mid forties.
For the full year, we expect revenue to be in the range of $700 million to $720 million.
We expect adjusted EBITDA margins to be in the range of 38% to 39% and non-GAAP earnings per share to be $1 65 to $1 69.
In 2023 free cash flow will increase as a result of our improved profit margin and lower capital expenditures driving 21% to 22% free cash flow margin for the full year, excluding the onetime costs associated with our workforce reduction and transaction costs.
<unk> adjusted EBITDA free cash flow will ramp throughout the year, and we expect free cash flow margin to approach, 30% by the fourth quarter.
That concludes my remarks, and I'll now turn it over to the operator to begin our Q&A session.
At this time I would like to remind everyone in order to ask a question Press Star then the number one on your telephone keypad. We ask that you. Please limit yourself to one question and only one follow up question.
First question comes from the line of Jim Breen from William Blair. Your line is open.
Hi, Thanks for taking the question.
Just on the revenue generation side on the revenue growth side can you just talk about.
Some of the more specific things youre seeing that sort.
Sure causes sort of push out the revenue guide for 2024, and then just on the buyback how confident are you in the in the free cash flow generation in case, there are opportunities for M&A.
And using that cash next.
Well in terms of the growth outlook.
Given what we're seeing currently.
And the outlook that we set for this year.
We've decided to push out the expectations for $1 billion.
Again that $1 billion target was organic and inorganic so.
But just to be cautious.
Facing the realities of what we're looking at that as the basis for our for pushing out.
The outlook.
By a year.
It's also the rationale for accelerating the margins as I said in the script, we see the two as related and and frankly, if you look at how we looked at the view of growing north of 30% through 2024 to get to that first $1 billion and ramping the free cash flow margin versus our current outlook.
The acceleration of margins, we're actually going to generate more free cash flow in the next couple of years that we would have under a higher growth scenarios. So we're very comfortable with the outlook and the margin mix and.
It's very important that you all understand that's exactly how we think about it.
In terms of.
Sure.
I'll comment on the free cash flow confidence we wait.
Way, we look at it is.
We prioritize.
Organic investment.
And making sure that over the next several years, we are taking care of building out our platform products et cetera, we've allocated a reasonable amount of.
A meaningful amount of capital for M&A accretive M&A.
And I think the M&A, we've done over the last year or two whether it's the cord ways in the $350 million range or.
Or a smaller single product company emerging from.
Feed stage.
As the framework for us from an M&A standpoint, so we've allocated a reasonable amount of capital for that and and we project at these higher margins have a pretty significant amount of excess free cash flow and returning a portion of that a meaningful portion of that to investors.
So it's a very balanced approach.
It's focusing on growth, it's focusing on optimizing operations for free cash flow margin, it's focusing on allocating capital to inorganic initiatives and is focusing on returning capital to shareholders.
Great. Thanks.
Your next question comes from the line of Gabriela Borges from Goldman Sachs. Your line is open.
Hi, good morning, Thank you.
<unk>.
Cyclical versus structural.
We came across all of our commentary on the macro for 2020 through commentary.
Let them on <unk>.
Structurally about Barney <unk> Barney on our final call on plans.
Thank you.
No.
Wallace from structural growth rate.
Thanks Charles.
It is not a long term target, it's very specific to our guidance for this year.
And and the realities of what we're facing this year and again, it's an organic growth rate.
For this year.
There isn't a change other than what we discussed earlier nothing changed competitively that we've seen.
We continue to drive.
We as I mentioned, there is more volatility with smaller customers.
And in terms of their growth.
That's a big aspect of the lower aggregate growth in our larger customers as I mentioned, we stay very close to them, we're investing in more talent and process to engage with even deeper numbers of those cohorts and theyre very consistent in our formal surveys, which we've conducted.
And in our anecdotal.
<unk> daily conversations with them. They are undergoing the same thing everybody is undergoing in the tech market, which is.
There are growth challenges, there and optimization mode et cetera, and Thats led to.
And we're helping them with that and frankly, we offer a value a compelling value proposition given the capabilities and the price point.
Value is really high so I think we're having great conversations so theres no real change other than everybody is just seeing a lower growth environment and we're working that through that with our customers, but as you as Matt laid out.
Larger customers once they breakthrough on our platform they are growing incredibly healthy.
Three handle almost four handle for the even larger customers and so I think they're doing that on our platform speaks to the value proposition in this environment.
And the fact that our.
Our cost proposition is so compelling so no change smaller customers more volatile, but as you see we still have a large enough pool, we're still adding enough in the pool as a sufficiently large that were still accelerating.
Graduation on our platform. So we feel very good about where we are and.
I think as things moderate one thing I'm really excited about with this newer cash flow profile when things do reaccelerate. If they do if they don't we obviously have compelling margins now we're going to positioned for even greater operating leverage in the future. So we feel good about where we are.
It's definitely a challenge different environment than we thought a year or two ago, but.
Think our economic model is proving very compelling.
In the midst of.
All of the uncertainty.
That's helpful. The follow up I think came on Opex, Colorado.
Those are rational.
Disappointing.
Sorry about.
Dustin so give us a sense, where did you find incremental efficiencies on the workforce reduction and the pace of investment in your direct sales force are you planning to accelerate the pace of investment in direct sales. Thank you.
Yes, well, we have invested and accelerated.
Even as we exited the year on the sales side.
As we've spoken to previously we have a narrower set of <unk>.
Incremental growth initiatives.
Really around enhancing our foundation around storage, we have a number of other new products that are either about to launch there in beta now or will as we approach the middle part of the year, we funded those through re prioritization.
In the first half of last year, as we slimmed down priorities as I mentioned earlier so.
On that side of the business, we feel like we've raised the bar on growth initiatives.
The hurdle rates higher and Thats, how we slimmed down the priorities in terms of the operating.
Structure, where we've found efficiencies.
It's really around.
Setting this business up we've gotten the 650 $660 million run rate.
Like most businesses what got you there or is it going to get you to $1 billion or $2 billion in revenue over time, and so we took this opportunity.
To kind of rethink how we work.
Simplify organizational structure importantly, globalize, our business and we've seen incredible success moving talent around the world and and Thats part of the of the activity.
So and then there is a number of other things that aren't even on the people side, they're actually contributing more of the efficiencies this year and going forward.
Evaluating where were spending our money and what do we need what do we not need and frankly I think it's what everybody.
In the Tech ecosystem is doing right now and you add all those up and Thats a meaningful contributor to the boost.
And our free cash flow and operating metrics that youll see this year.
Thank you Cynthia.
Your next question comes from the line of Tim Horan from Oppenheimer. Your line is open.
Thanks, guys.
Focusing on revenue it seems like you're looking for a pretty big ramp for the second half of the year, because youre like 1% sequential in the first quarter and we kind of need more like 5% sequential for the next three quarters to hit the low end of the guidance are you planning any price increases or.
Are these new products and to drive that just talk about how we're going to see that acceleration.
The low end of the guidance reflects nothing different from where we're at.
Executing now and at the upper end reflects incremental initiatives, we've talked about contributing.
Whether it's there is some monetization actions they wouldn't be explicit price increases, but as bundling packaging.
Are in the mix.
Which will have the net effect of pricing leverage.
George capabilities coming online middle of the year.
And it's some of the near term initiatives, we have as well as our investments incremental investments in sales.
Our partner capability.
Our inside sales capability. So those are contributing near term we have our Sydney data Center, which I mentioned came online in Q4 is ramping very nicely. So it's a host of things.
Many of which were in flight as we entered this year already and market and some near to coming into market.
Others coming in Q2, Q3, and you add all those up and Thats, how you get to the upper end of the range.
Got it but to be clear I mean annualized in the first quarter, you were kind of bit more well below the low in the guidance. So there's a bunch of things that are hitting that it's just a timing issue the more hitting the second and third quarter that kind of drive the revenue growth to be clear.
The low end of the guidance reflects nothing really changing incrementally from those contributing from those initiatives. The upper end of the guidance reflects more contribution from those initiatives the middle is.
Balance of the two and we will see ramping it's important though a number of those initiatives are in flight so there'll be some.
Generally available.
Over the next few weeks exit this quarter as we get into Q2. So there's plenty of time for this year for those to contribute some of those are monetization pricing packaging bundling options et cetera, and so.
We will see a ramp through the year.
And our guidance reflects our cautious outlook in the aggregate towards the.
Short term, reflecting some of the macro uncertainties.
Or that we're facing.
Thank you.
Your next question comes from the line of Jim Fish from Piper Sandler Your line is open.
Hey, guys. Thanks for the questions I wanted to touch upon the actually the last one here.
The investment behind the direct sales force, but kind of a pullback in spending in other areas of the business. Just can you talk about how you're setting quotas in.
What you're expecting for quota carrying capacity.
Ramps and what gives you kind of confidence and has changed from.
The self serve model to a direct more direct led model.
This direct led model will actually result in an uptick of adoption given how we think about the typical size of your installed base and how they can assume digital lotion.
Lynn.
In other areas of attack, we've seen others try to move from kind of self serve to direct not go while really my question is what gives you confidence that direct sales force shift will result in incremental uptick here.
Well, there's two points I would make first of all let me clarify what invest in sales means.
What you said earlier one it's inside sales. So we have as you pointed out a large cohort of customers. We've seen significant success over the past few years.
Adding inside salespeople expanding the number of people, who we assigned two accounts.
And they are working directly with those accounts to optimize them on the platform. That's led arco acceleration multi product adoption better use of the cloud better.
And we've helped our customers scale. So we've seen a lot of.
Our success there and in fact, we added pretty meaningfully in Q4, two that team. So that we can go even deeper many thousands tent up plus thousands of customers that we're actually talking to now versus.
Low single digit thousands.
This time last year. So that's a very important distinction it's really.
Enhanced support customer success inside sales motion, we've already demonstrated that.
That model, a very successfully and then our partner channel.
As I mentioned, there is a host of digital agencies hundreds of thousands of them around the world managed hosting providers.
Example, cloud waste is one of them and we work we've formalized and tailored.
And offering to them and we've seen.
That stood that up as we got through last year, and we expect that to see meaningful traction we already have lots of agencies on our platform organically through organic self serve even.
And we're looking to enhance that through bigger efforts.
Through this partner pod capabilities.
Capabilities. So those are there.
I would say.
And for this year or they wouldn't be bigger than the amount of revenue we generate from self serve but they've been very complimentary and ramping very rapidly ours is always going to be a business as Matt eloquently laid out.
The pool of customers that test come to digital Ocean, a test and learn is massive.
And that we're always going to build the ecosystem around that because that ecosystem is driving so much of our growth through the graduation.
From a sub 50 to a greater than 50% greater than $500 customers.
If I could follow up on that.
How do you guys plan to balance having your own internal agency here with cloud ways versus kind of be external digital agency partners.
Could potentially create friction and then when do you expect that storage percentage to actually double that of 2023 thing or is that kind of more of a 2000 22025.
Thanks, Dan the second we haven't set a target for the day, we just want to make meaningful progress and I think.
As we add features and functionalities over the and it's important we are making progress we substantially increase the response times <unk>.
Cycles per second of storage in Q4, we obviously added snapshooter from an acquisition.
Earlier this quarter, we will have more features and functionality coming online. So the two acts as a longer term target. That's how we benchmark against other folks in cloud we haven't put a date on it we just want to be making progress and as we make progress and accelerate that.
A significant boost to our growth rate on the first one.
No channel conflict again, this is a $100 billion market for SMB cloud developer and Dell developer cloud, it's a big market. We did a lot of diligence when we looked at cloud ways around whether there would be channel conflict, we have seen no churn on our platform.
Companies, who do similar things to cloud way since the acquisition.
There is no concern on our end about that after a significant amount of diligence on this theme and topic.
<unk> for both before signing the transaction and obviously we've owned the company now for five months just has not been an issue.
Your next question comes from the line of Michael <unk> from Keybanc capital markets. Your line is open.
Hey, Good morning, this is Keith on for Michael.
So you talked about it seems cloud ways being more resilient and core digital Ocean is there anything different about cloud ways, whether the customer base.
Value prop that makes it a bit more of a resilient business and then a quick follow up.
It's a question we ask all the time I don't know that we have.
Resolution on that.
And.
And so I don't want to speculate on that right now, but there's no question that as the business has been quite resilient.
Do have a higher percentage of those $50 enough customers and we do we're mid teens the legacy deal.
And our cloud lasers in the mid <unk>, So I think thats an aspect of it.
But.
It's a and as I said in the script, we're taking a lot of learnings and applying them to the whole company. So really excited.
<unk>.
To make a large acquisition like that for us our largest in the middle of 2022, a year have a ton of uncertainty and.
To have it play out as it's playing out we're really excited about where we are and the prospects ahead.
Okay, and then just quickly on that.
Part of the thesis I think of bringing decline was was to kind of reduce that churn that you're kind of often see with those customers in the first 90 days or one years is there any progress you're seeing on that front number one and then number two just curious if youre seeing any progress or opportunities to cross sell cloud ways to kind of that broader digital ocean base.
Yeah. So we've been very focused in this first several months on the customers who come to digital Ocean, who werent best suited for our do it yourself model and manage was a better.
The opportunity for them, we've changed a lot of our onboarding flow and I mentioned.
More than 15% boost in net new customer acquisitions from the cloud ways in the first few months. That's a big reason, so we are effectively capturing more value that.
A year ago, two years ago, we might have been missing out on are having churn.
We just weren't the best match.
The market size for managed.
At least as big as sort of our core model. So that's really exciting to have a thesis for an M&A transaction and in months into it already confirming that so we feel good about that we are working on.
Other cross sell motions that just have been later in priority and are starting to kick in now and look forward to updating you.
Our investors as we move through the year on that theme, but again very excited about the progress to date.
And and even more excited about what's to come.
Great. Thanks Nancy.
Your next question comes from the line of <unk> Mohan from Bank of America. Your line is open.
Hi, yes. Thank you good morning, and nice to see the profitability pull in but I was wondering if you could comment on on the cost actions you are taking it at full run rate that should be driving 800 bps of EBITDA improvement and Youre guiding for a 500 basis points of.
EBITDA expansion in 'twenty three.
As you look forward are you converting the incremental dollar of revenue at the same better or worse operating leverage ex these cost initiatives and our restructuring plan that you are taking in and what's the long term growth profile for expenses.
So.
Clumsy it's Matt.
Just to talk to you again.
If you look at the total run rate impact of the cost savings that we're projecting at $60 million a year on an annual basis 35, which is as non head count related 25 as is head count related and as Nancy said, we've seen the opportunity to re prioritize some of the investments that we're making in the business.
To focus on the higher growth and higher return.
Initiatives and that's what's enabled us to.
To drive those costs out again, we're also taking advantage of the globalization of our company and moving our resource base to more closely match the kind of the revenue base of the company, which is about 70% international.
So we think there's a lot of opportunity for us to continue to optimize that while still making very very effective and strong investments that have good return on invested capital. So we see incremental operating leverage part.
Part of the challenge for this year is the costs are going to come in over the course of the year and.
It's going to take a while for the dose.
Those cost effects to manifest themselves in our margins and so that's why in my Mark remarks, I tried to guide a little bit towards how we think that we're going to exit the year and we think again from a EBITDA margin standpoint, we should be exiting the year in the low to mid forties and from an EBITDA margin and from a free cash flow we should be.
Approaching the 30% by the end of this year and we expect to see further margin improvement going forward.
Yes, if I can just add one point to that if you think about if we take a step back what does it mean for Matt to say, we will exit this year at 30% free cash flow margins.
It was just three years ago, we had negative 25% free cash flow margins, so you're talking about 55% increase.
And three years as the business has gone from about $240 million of revenue to 650 or seven a little over $700 million in revenue.
Free cash flow conversion well over 50.
On every incremental revenue dollar.
So I just wanted to make sure we're clear.
We're very focused on incremental leverage in the business and we've already delivered it and I think youre going to see a substantial improvement in that this year.
Even in a lower growth environment.
Okay. Thank you.
And as a follow up.
I appreciate the details on the learners and builders scanners that you gave.
What is driving the improvement from learners to builders graduation rates in 'twenty. Two how much was that was how much of that was a push versus pull effort and how are you expecting that the trend in 23. Thank you.
Yes.
So great question.
I think as we've added multi more products over the last few years.
Managed databases managed <unk>.
Enhanced our marketplace our services portfolio, we've given we've enhanced our.
Our infrastructure compute network and storage solutions, we've added more capability to the platform and so what that's enabled us to do and this is why storage is so important these investments.
As color as companies grow their needs for cloud evolve.
And if you look at US three to five years ago with a similar product set we couldnt capture as much share of wallet as their cloud spend group we.
We are now able to over the past few years through our investments capturing more share of wallet pushing out for example, the time a company may go multi cloud and certainly capturing more of the two applications theyre needing as they grow their businesses I think that's a principle sort of from the product side and then as I talked about earlier are.
Investment in inside sales and enhancing our customer service value proposition.
This helped facilitate that by making customers more aware building a really good muscle and working closely with customers. So it's the combine of the product strategy and then our go to market strategy, which has been driving that acceleration in ARPA and just one thing to add and we included this data in the in the earnings.
<unk> supplement, but if you look back all the way to 2018.
The part of the power of this model and the elegance of this model is how consistent and improving the graduation rate has been and how consistently we've been adding builders and adding scale as you look back over the last five years that is just up into the right you can't even see a blip during the.
Or any impact during the pandemic you don't see really any changes other than the recent acquisition of cloud ways and the pricing action of July it's an incredibly durable model.
Thank you.
And your final question comes from the line of <unk> Srinivasan Raghavan from Barclays. Your line is open.
Hi, Thanks for taking my question here.
Just wanted to follow up on the last one you mentioned exiting the year and approaching 30% for free cash flow margins is it also fair to say you will exit the year at or approaching a rule of 50.
Yes.
Great and.
Dan I wanted to talk about early adoption of cloud ways as well.
Customer cohorts can you maybe on a breakdown.
Customer spending 50 to 500 versus those who are spending over 500 are you seeing any different behavior.
Adoption in China, so far.
I'm sorry are you speaking just specifically to cloud ways.
Yes, just with cloud weighs on those days.
Is it more just broad based adoption among your base or are you seeing let's say your largest customers John or smaller ones adopting more than others.
Adopting cloud ways.
Yes.
Well as I mentioned earlier, you're seeing a boost in the $50 and up.
Especially.
When considering that 15% or better boost to net new customers.
Significant percentage of those are $50 up customers.
In terms of the synergies we referred to.
I don't have the data, whether it's the 500 and up but.
Again, a core aspect of the thesis people, who want a managed service absolutely are going to run a business.
And so they have aspirations to grow really rapidly and it's a great time as theyre looking to set up their cloud infrastructure to ask them do you want to do it yourself or do you want to manage experience, which by the way is roughly two X the price.
Go managed.
And they frequently will choose the managed and so we.
We see that as a compelling essentially a product extension really front and the entire digital ship programs platform.
Platform, so we'd expect it to skew higher ARPA.
Over time and to drive higher ARPA.
Just reflecting cloud ways is roughly a quarter of their customers are $50 up versus the legacy deal was about 15%. So it's going to certainly improve the <unk>.
Of builders and scalar on our platform.
Thanks, and congrats again.
Yes.
And this concludes our question and answer session I will turn the call back over to Andy for some closing remarks.
Thank you for joining us this morning I.
I hope its obvious we are.
Really excited about the progress we've made in transforming.
Our company digital Ocean.
Into a durable high growth business and a free cash flow machine in.
In good times and in bad.
We look forward to continuing the conversation in the coming weeks and months ahead.
As we work hard to realize this limit the potential of our business have a great rest of the day.
This concludes today's conference call. Thank you for your participation you may now disconnect.
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